Title: Introduction to Macroeconomics
1Introduction to Macroeconomics
2What is Macroeconomics?
- Macroeconomics is the study of the structure and
performance of national economies and of the
policies that governments use to try to affect
economic performance of a country.
3Issues in Macroeconomics
- What determines a nation's long-run economic
growth? - What causes a nation's economic activity to
fluctuate? - What causes unemployment?
- What causes prices to rise?
- How does being part of a global economic system
affect nations' economies ? - Can government policies be used to improve a
nation's economic performance?
4 5Long - Run Economic Growth
- Difference in standard of living in different
countries. - Some economies experienced sustainable economic
growth. - Some nations have never experienced sustained
growth or have had periods of growth offset by
periods of economic decline. - Hence the period of rapid economic growth which
is offset period of economic decline is known as
long run growth.
6Output of the U.S. economy 1869-2008
7- The long-run growth in USA is a result of
increase in population and average productivity
of labour Force. - APL TP/L
8Business Cycle
- Macroeconomists use the term business cycle to
describe short-run, but sometimes sharp,
contractions and expansions in economic activity. - The downward phase of a business cycle, during
which national output may be falling or perhaps
growing only very slowly, is called a recession.
9Unemployment
- Unemployment is the number of people who are
available for work and are actively seeking work
but cannot find jobs. - It is measured by unemployment rate.
- Ur Number of unemployed/Total labour force
- Recessions have led to significant increases in
unemployment.
10Analytical Question
- Can average labour productivity fall even though
total output is rising? Can the unemployment rate
rise even though total output is rising?
11Inflation
- When the prices of most goods and services are
rising over time, the economy is said to be
experiencing inflation. - The percentage increase in the average level of
prices over a year is called the inflation rate. - High inflation also means that the purchasing
power of money erodes quickly.
12Problem No.1
- Here are some macroeconomic data for the country
of O for the years 2008 and 2009.
2008 2009
Output 12000 14300
Employed 1000 1100
Unemployed 100 50
Total labour force 1100 1150
Prices 2 2.5
13Required
- a. Average labour productivity in 2008 and 2009.
- b. The growth rate of average labour productivity
- between 2008 and 2009.
- c. The unemployment rate in 2008 and 2009.
- d. The inflation rate between 2008 and 2009.
14What Macroeconomists Do?
- Macroeconomic Forecasting
- Macroeconomic Analysis
- Monitoring of the economy and think about
- the implications of current economic events.
- Macroeconomic Research
15Economic Theory
- An economic theory is a set of ideas about the
economy that has been organized in a logical
framework. Most economic theories are developed
in terms of an economic model. - Economic model is a simplified description of
some aspect of the economy, usually expressed in
mathematical form.
16Economic Policy
- Set of instruction to control the performance of
the economy. - There are two types of macro economic policies
- Fiscal Policy
- Monetary Policy
17Economic Analysis
- Positive Analysis
- Normative Analysis
18Positive Analysis
- A positive analysis of an economic policy
examines the economic consequences of a policy
but doesn't address the question of whether those
consequences are desirable. - e.g. if a tax is imposed on a good its price will
tend to rise.
19Normative Analysis
- A normative analysis of policy tries to determine
whether a certain policy should be used. - e.g. a tax should be imposed on tobacco to
discourage smoking
20Analytical Question 2
- Which of the following statements are positive in
nature and which are normative? - a. A tax cut will raise interest rates.
- b. A reduction in the payroll tax would primarily
benefit - poor and middle-class workers.
- c. Payroll taxes are too high.
- d. A cut in the payroll tax would improve the
President's - popularity ratings.
- e. Payroll taxes should not be cut unless capital
gains taxes are cut also.
21Classical Versus Keynesians
- Classical Approach
- Adam Smith (1776)
- Published book Wealth of Nation.
- Concept of invisible hand
- Keynesian Approach
- Great Depression (1936)
- John Maynard Keynes
- General theory of Employment, Interest and Money
22The Classical Approach
- The invisible hand of Economics General welfare
will be maximized (not the distribution of
wealth) if - there are free markets
- individuals act in their own best interest.
23The Classical Approach (continued)
- To maintain markets equilibrium the quantities
demanded and supplied are equal - Markets must function without impediments.
- Wages and prices should be flexible.
24The Classical Approach (continued)
- Thus, according to the classical approach, the
government should have a limited role in the
economy.
25The Keynesian Approach
- Keynes (1936) assumed that wages and prices
adjust slowly. - Thus, markets could be out of equilibrium for
long periods of time and unemployment can
persist.
26The Keynesian Approach (continued)
- Therefore, according to the Keynesian approach,
governments can take actions to alleviate
unemployment.
27The Keynesian Approach (continued)
- The government can purchase goods and services,
thus increasing the demand for output and
reducing unemployment. - Newly generated incomes would be spent and would
raise employment even further.
28Evolution of the Classical-Keynesian Debate
- After stagflation high unemployment and high
inflation of the 1970s, a modernized classical
approach reappeared. - Substantial communication and cross-pollination
is taking place between the classical and the
Keynesian approaches.
29Unified Approach to Macroeconomics
- Individuals, firms and the government interact in
goods, asset and labour markets. - The macroeconomic analysis is based on the
analysis of individual behaviour.
30The Unified Approach (continued)
- Keynesian and classical economists agree that in
the long run prices and wages adjust to
equilibrium levels. - The basic model will be used either with
classical or Keynesian assumptions about
flexibility of wages and prices in the short run.
31The Measurement and Structure of the National
Economy
32National Income Accounts
- The national income accounts are an accounting
framework used in measuring current economic
activity.
33Approaches of Measurement
- Product Approach (excluding output used in
intermediate stage of production). - Income Approach (income received by the producer
of output) - Expenditure Approach (amount of spending by the
ultimate purchaser of the output).
34Product Approach
- The product approach measures economic activity
by adding the market values of goods and services
produced, excluding any goods and services used
up in intermediate stages of production. - Concept of value added (value of output minus
value of input)
35Income Approach
- The income approach measures economic activity by
adding all income received by producers of output - Rent, are the income from from property received
by house hold - Interest, Private business pay to house hold
- Wages, received by workers.It is largest
component of National Income - Profit, received by owners of firm
36Expenditure Approach
- The expenditure approach measures activity by
adding the amount spent by all ultimate users of
output.
37The Expenditure Approach to Measuring GDP
- The expenditure approach measures GDP as total
spending on final goods and services produced
within a nation during a specified period of
time. - Total spending on goods and services includes
- Consumption (C)
- Investment (I)
- Government Expenditure (G)
- Net Export (NX)
38Consumption
- Consumption is spending by domestic households on
final goods and services, including those
produced abroad. - Consumption expenditures are grouped into three
categories - Consumer durables (car, television, mobile)
- Nondurable goods (food, cloth, fuel)
- Services (Education, Health care, Financial
Services)
39Investment
- Investment includes both spending for new capital
goods, called fixed investment, and increases in
firms' inventory holdings, called inventory
investment. - Fixed investment in turn has two major
components - Business Investment
- Residential Investment
40Government Expenditure
- Government expenditure include any spending by
the government for a currently produced good or
service. - It also include the transfer payment (benefit) to
the individuals of the country.
41Net Export
- Net exports are exports minus imports.
- If exports are greater than imports NX gt0.
- If exports are less than imports NXlt0.
42Income-Expenditure Identity
- Y GDP total production (or output)
- total income
- total expenditure
- Y C I G NX.
43Fundamental Identity of NationalIncome Accounting
- total productiontotal incometotal expenditure
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45Gross Domestic Product
- Gross domestic product used to measure the over
all economic activity of a country. - GDP is calculate by using the following
approaches - Product approach
- Expenditure approach
- Income approach
46Product Approach
- A nation's gross domestic product (GDP) as the
market value of final goods and services newly
produced within a nation during a fixed period of
time.
47Market Value
- Goods and services are counted in GDP at their
market values that is, at the prices at which
they are sold. - Advantages
- It allows adding the production of different
goods and services. - Disadvantages
- Some useful goods and services are not sold in
formal markets.
48Market Value (Cont)
- Some nonmarket goods and services are partially
incorporated in official GDP measures. An example
is activities in the so-called underground
economy. - The underground economy includes both legal
activities (hidden from government record keepers
to avoid payment of taxes) and illegal activities
(drug dealing and gambling).
49Newly Produced Goods and Services
- As a measure of current economic activity, GDP
includes only goods or services that are newly
produced within the current period.
50Final Goods and Services
- Only the value of final goods and services
include in the measurement of GDP. - Final goods also include capital goods and
inventory investment.
51GDP Versus GNP
- Gross National Product is the market value of
final goods and services newly produced by
domestic factors of production during the current
period, whereas GDP is production taking place
within a country. - GNP GDP NFP
- GDP GNP - NFP
52Net Factor of Payment
- NFP is the income earned by the domestic factor
of production from the rest of the world. - From the above definition,
- GDP GNP NFP
- In developed economies GNP GDP.
- In Underdeveloped economies GNP gt GDP.
53Measures of National Income
- Net National Product
- Less Capital Consumption Allownce
- Add Subsidy
- National Income at market price
- National Income at factor cost
- Personal Income
- Personal Disposable Income
54Private Disposable Income (PDI)
- Private disposable income, measures the amount of
income the private sector has available to spend. - Mathematically,
- PDI Y NFP TR INT - T
- Y gross domestic product (GDP)
- NFP net factor payments from abroad
- TR transfers received from the government
- INT interest payments on the government's
debt - T taxes.
55Net Government Income (NGI)
- Net government income equals taxes paid by the
private sector, T, minus payments from the
government to the private sector (transfers and
interest payments on the government debt) - Mathematically,
- NGI T TR -INT
56Saving
- Private Saving private saving is equal to
private disposable income minus consumption. - Spvt (YNFPTRINT-T)-C
- Government Saving It is defined as net
government income less government purchases of
goods and services. - Sgov (T - TR - INT) -
G.
57National Saving
- S Spvt Sgov
- (YNFPTRINT-T)-C (T - TR - INT) - G.
- S I CA
- Uses of Spvt
- 1, Spvt is used to fund new capital (Investment)
- 2, Provide the resource to Govt needs to finance
its budget deficit (-Sgov) - 2, Foreign lending
58Current Account (CA)
- The current account balance equals payments
received from abroad in exchange for currently
produced goods and services (including factor
services), minus the analogous payments made to
foreigners by the domestic economy. - CA NX NFP
- NX X M
- NFP Income from abroad Payment made to abroad
59National Wealth
- The value of all assets own by a person or
country. - Current assets Current Liabilities
- It is total wealth of the residents of a country,
it consist two parts - 1, Domestic physical assets (Stock of capital,
goods, Land) - 2,Net foreign assets Countries foreign
assets(foreign stock, bonds and factories own by
domestic resident) minus its foreign liabilities
(domestic physical and financial assets own by
foreigners) - Note Domestic financial assets held by domestic
residents are not part of National wealth.
60National wealth can change in two ways.
- 1, Value of existing assets or liabilities that
make up national wealth - Stock Prices
- The wearing out or depreciation of physical
assets which corresponded to a drop in the value
of asset - 2, National Saving
- Increase in domestic stock of capital
- Increase in stock of net foreign assets
- ( NXNFP)
61Nominal and Real GDP
- Nominal GDP measure the current dollar value of
the output of the country - Total output at current prices
- Y Pn X Qn
- Pn new price, Qn new
Quantity - Real GDP measure output at base year or constant
prices - Y Pb X Qn Pb Base year price
62GDP deflator
- The GDP deflator is a measure of the level of
prices of all new, domestically produced, final
goods and services in an economy - GDP deflator nominal GDP / Real GDP
- Pn X Qn / Po X Qn
- Real GDP nominal GDP / GDP deflator
- nominal GDPReal GDP X GDP deflator
63Consumer Price Index ( CPI)
- Consumer Price Index
- measures changes in the price level of a market
basket of consumer goods and services purchased
by households. The CPI in the Pakistan is defined
by the ministry of finance as "a measure of the
average change over time in the prices paid by
urban consumers for a market basket of consumer
goods and services.
64Calculation of Growth rate
- Growth Rate
- (Current Previous/ Previous) X100
65Difference b/w CPI and GDP price Index
- Three main differences are
- 1, GDP deflator measure prices of all goods
services produced where as CPI measure the prices
of only goods services bought by consumer. - 2, GDP deflator shows the prices of all goods
services produced domestically, imported goods
are not included in GDP deflator. CPI consider
imported goods. - 3, CPI is computed using fixed basket of goods.
GDP deflator allows the basket of goods to change
overtime as the composition of GDP deflator.
66Cost of Living
- The dollar does not buy as much as it did ten
year ago the cost of every thing almost gone up. - Which price index better explain increase in cost
of living. - GDP deflator ( understate increase in cost of
living) - Base year price
- CPI ( overstate cost of living)
- substitute goods
67Interest rate
- Rate of return promised by a borrower to a lender
is called nominal interest rate. - Real Interest rate ( r)
- An interest rate that has been adjusted to remove
the effects of inflation to reflect the real cost
of funds to the borrower, and the real yield to
the lender. - Real Interest Rate Nominal Interest Rate -
Inflation (Actual) - The real interest rate of an investment is
calculated as the amount by which the nominal
interest rate is higher than the inflation rate. - Expected Real Interest Rate Nominal Interest
Rate - Inflation (Expected)
68- Stock variables
- measure at a point of time like money supply
- Flow Variables
- Variables that can measure per unit of time
- GDP
69Circular Flow of Income In Closed Economy
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